Change Of Law: VAT Treatment Of Voluntary Carbon Credits

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HMRC have published a Revenue & Customs brief outlining a change in the VAT treatment of voluntary carbon credits.
UK Tax
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HMRC have published a Revenue & Customs brief outlining a change in the VAT treatment of voluntary carbon credits (VCCs).

What are voluntary carbon credits?

VCCs allow businesses to offset their emissions by purchasing carbon credits produced by programmes targeted at removing or reducing greenhouse gases from the atmosphere. Each credit can be used to compensate for the emission of one tonne of carbon dioxide or equivalent greenhouse gases. These carbon credits are "voluntary" in the sense that the use of carbon credits to reduce emissions is not legally required or regulated.

Current VAT treatment

For VAT purposes, HMRC currently draw a distinction between compliance credits (credits recognised under regulated emissions trading systems) and VCCs. To date, supplies of VCCs have been treated as outside the scope of VAT on the basis that supplies of such credits were not regarded as being capable of forming the cost component of the activity of another person in the commercial chain.

Future VAT treatment

From 1 September 2024, sales of VCCs which take place in the UK will be capable of being taxable supplies. HMRC have stated that this change is a result of significant changes in the VCC market, including the emergence of secondary market trading and businesses incorporating VCCs into their onward supplies. However, not all supplies of VCCs will be taxable supplies (i.e. within the scope of VAT). For example, holding a VCC as an investment does not constitute an "economic activity" so will continue to be treated as outside the scope of VAT. Sales of VCC by self-assessed projects with no independent verification also will be outside the scope of VAT.

HMRC have also updated their internal manuals, outlining factors that could be considered when assessing whether a supply of a VCC is a taxable supply or outside the scope of VAT. The existence of a tradeable instrument, a quantifiable reduction in greenhouse gases and independent verification and registration of the unit are all pointers towards a taxable supply.

From 1 September 2024, trades in VCCs will be brought within the scope of the VAT Terminal Markets Order (TMO). The TMO provides for the zero rating (VAT charged at 0%) of certain commodity transactions on named commodity exchanges or "terminal markets".

Impact of change of law

The changes announced in the brief are likely to improve the VAT position of businesses generating voluntary carbon credits (e.g. landowners planting woodlands) as by charging VAT on the sale of VCCs, these businesses may be able to recover more of the input VAT they have incurred in generating the VCCs, but could result in additional costs for VAT exempt and partially exempt purchasers of VCCs, as they may now need to pay VAT on purchases of VCCs but will not be able to fully recover that VAT cost.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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